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Stop the Madness!

Markets fell, gold soared, China scolded, and Obama made a speech. But economists from all over the country say it’s all just politics.

08.08.11 9:51 PM ET

Kick the Adolescents Out of WashingtonPeter Karl Kresl, Professor of Economics Emeritus, Bucknell University Lewisburg

Standard & Poor's was not out of line in calling into question the situation of the U.S. economy. But I do not see us as being unable to pay the interest on our financial obligations. When a spokesman for S&P noted, however, that none of the remedy should come from increased revenues, just from cutbacks on entitlements, etc., it became clear to all that S&P is simply an arm of the right wing of the Republican Party—Repubsymps, so to speak. They knew they could take this cheap political shot because nothing would happen in the U.S. unless another rating agency also downgraded the debt. This would force many entities to sell U.S. obligations so they could stay with AAA-rated instruments.

Tough talk must come from somewhere. Sadly, President Obama has become the best moderate Republican since Charles Percy. Treasury Secretary Timothy Geithner is far from perfect, but he is the only one with big antlers left. Obama simply has to recruit some economists with the competence, status, and values of Joseph Stieglitz or Paul Krugman.

Europe is, of course, the big item. Not only is its leadership inept and timid, but it lacks the necessary requirements for an "optimal currency union"—free labor mobility (language and local requirements, etc., limit this mobility) and a fiscal union so transfers flow freely from one region to another. So the euro is actually in jeopardy. The U.S. has both of these; we just lack a set of adults in Washington (we are saddled with the arrested adolescents we so foolishly sent there) who can convince the rest of us that they can actually implement the policies everyone other than the Republican right and their allies knows should be implemented. We cannot determine what goes on in the EU, so we should focus on getting our own economy in good shape. We should also try to forge better and more cooperative relations with Asian economies—Europe is yesterday's project. Given the turmoil all of this has created in Asian markets, they might be interested in talking with us now.

Economics Is the First Casualty of PoliticsEdward B. Barbier, Professor of Economics, University of Wyoming

Both the past wild week of debt negotiations in Congress and the debt downgrade of the U.S. by S&P represents once again the Barbier dictum: economics is always the first casualty of politics.

In my opinion, the Obama administration made a fundamental mistake earlier this year in not endorsing the Bowles-Simpson plan on deficit reduction. It called for a combination of revenue increases, spending cuts, and entitlement and tax reforms as the basis of a plan for deficit reduction over the medium term. At the same time, the plan argued that there is the need for continued government spending on selected infrastructure and investment opportunities in the short term while continuing to be in recession. From the beginning of the 2008–09 recession, such short-term government spending needed to be supported by a number of economic incentives and policies to stimulate private-sector investment, too. However, as long as the U.S. economy remains in a recession with lack of consumer or private-investment spending, public-sector spending in the short term is necessary. But by adopting the Bowles-Simpson plan immediately, the Obama administration would have signaled to the markets and the rating agencies that tackling U.S. deficits and debt in the medium and long term, once economic recovery had started in earnest, would be the main priority.

Instead, the last week or two has demonstrated that sound economic policy has been hijacked by an ideological political debate that has focused purely on cutting spending and not managing either the recession or medium-term budget deficits. Clearly, the Republican Party has been irresponsible in promoting this ideological political stance, and as a consequence, has brought the U.S. economy to the brink. Although one can agree with Treasury Secretary Timothy Geithner that S&P is making its U.S. debt-downgrade decision based on political considerations, the wakeup call to U.S. policymakers should not be ignored: stop playing politics with the U.S. and world economy. This is a message that the Republican leadership in Congress must especially heed.

As for the president’s speech today, what we need from Obama is not just more reassuring speeches peppered with a few economic ideas but concrete actions and policy plans to back up this short-term/long-term approach that Obama is advocating.

At a time when the political system is dysfunctional, it is even more important to demonstrate a clear vision of how to steer the economy out of this mess, rather than allow politics to continue to dominate sound economic thinking.

First, we should stop being so concerned with the day-to-day behavior of global stock markets and foreign-exchange markets (which determines the price of the Swiss franc). On a day-to-day basis, these markets represent almost nothing but gambling games. Worse, their ups and downs reflect only short-run events (China scolds...) and not what we need, i.e., long-term perspective. Stock-market indices measure the "mood of Wall Street," but what is important is the persistently high unemployment rate and the slow growth of real GDP.

Stock markets are poor leading indicators, having only a weak connection with future changes in GDP. In fact, almost all of the causation goes the other way: if GDP stagnates and/or inflation speeds up, that usually causes stock markets to fall. Stock-market fluctuations only matter when they are sustained (a big bull market like that of the late 1990s) or suffer from large changes (1929, 1987, 2008, etc.) In the end, it's the "real economy" (real GDP growth, unemployment, inflation, etc.) that matters.

By the way, gold is even more of a speculative commodity than stocks. Over the long haul, both are hedges against inflation. Beyond that, the only way one can profit from gold is via capital gains, which correspond to someone else's capital losses (unless they're only on paper). A zero-sum game. On the other hand, with stocks, there's the promise of stockholder earnings that arise from a company's flow of profits (made via creating and/or selling real products). Those corporations aren't losing in this process, so there's no loss corresponding to a stockholder's capital gain on stocks.

Second, I think that S&P's downgrade decision is really nothing but a statement of a political position. It also comes from a company that is really bad at evaluating anyone's creditworthiness (cf. 2008). Treasury Secretary Timothy Geithner is right on this issue.

Given the state of the job market, Geithner might have a hard time finding a new job. But seriously, folks, he's probably staying on since it's so hard to get Congress to OK a replacement. I don't see his staying on as either positive or negative, since the president would replace him with someone who's very much the same. If President Obama wants to kowtow more to "the markets" (Wall Street), he might appoint someone like Summers or Rubin. But that would mostly be a PR move. Those fellows agree with Geithner 100 percent (or close to that).

Third, European financial markets will suffer more, since the Economic and Monetary Union has much more serious problems than the U.S. does. It's not really a matter of who the secretary of the Treasury is.

The U.S Economy Is Being Held HostageDr. Michael H. Belzer, Associate Economics Professor, Wayne State University

The S&P probably was justified in downgrading the U.S. but only because our political paralysis is holding rational economic policy hostage. The trigger for this event was the brouhaha over raising the debt limit. The debt-limit problem is a phony crisis because the very same people who voted to spend the money also voted against raising taxes to pay for what they spend, and then voted against raising the debt limit to pay for the borrowing for which they voted. Their disingenuous hardline antigovernment stance (contradicted by a desire to take stimulus and other funds from the government) created this crisis; it is legislator-made. The right wing is responsible for creating the debt-limit crisis, and if they are allowed to hold the rest of us hostage, they will bring down the economy. Today's 600-plus-point fall in the Dow suggests they may have succeeded, though I don't think this was what they intended. They just think that the ends justify the means.

Treasury Secretary Timothy Geithner was the wrong guy from the beginning. He was always a part of the problem and the only downside there would have been to his leaving is the inability of the president to find a replacement whom Congress will confirm. This would takes us right back to the problem discussed above: you cannot negotiate with hostage takers or terrorists because they may be just as happy if the negotiation fails; they believe that their cause is sufficiently righteous that if they die blowing the rest of us up they will die as martyrs and go straight to heaven. How can anyone negotiate with people like this?

I have believed for the last year and a half that the euro is doomed. This ill-conceived experiment was fundamentally flawed because the currency lacks a centralized government and policy is disconnected from consequences. National leaders play to the median voter in their constituency, not to Europe. The most powerful European domestic constituency is the banking and finance industry, so all this talk about bailing out periphery countries is just a cover for bailing out the banks that have lent irresponsibly, with the expectation that European taxpayers will bail them out; so European policy failure is leading to a failure of the European economy. If the U.S. was governed responsibly (see the first paragraph again), then I would not be worried because the U.S. economy is strong enough to team with Asia to prevent the world economy from imploding. But with the U.S. economy held hostage by a radical fringe, all bets are off.

Forget Economics, It’s All PoliticsDorene Isenberg, Professor of Economics, University of Redlands

Of course the U.S. economy is in a terrible spot: a nonrecovery for nonworking Americans. But that's not what the S&P downgrade is about. Even in this terrible global economic situation, the U.S. can and will meet its debt obligations, which is all that a credit rating is supposed to assess. Whether it's the president's investigation of the 14th Amendment or Greenspan's acknowledgement that we can always "print" money, a U.S. default on its debt obligations isn't in the cards.

So, why did S&P downgrade U.S. debt? Ostensibly, it's about politics.

S&P notes that Medicare and other entitlement spending needs to be brought under control. But Social Security is currently self-financed and our health-care reform will reduce Medicare expenditures as the CBO has reported. The S&P rationale hangs its changed view on Congress' political divide and specifically on its future recalcitrance to letting the 2001 and 2003 tax reductions for high-income earners expire. Yes, that's going to be a major fight, but in today's speech, the president indicated his support for their expiration and that this would be a focal point for the upcoming congressional committee of 12. This is not a done deal, and if this one point is the major rationale in S&P's decision, then it's not about our economic capability to pay our debts. We can. S&P is off its mark, as it has been many times before.

But might there be another side to this action? Could it also be about flexing muscles? As financial regulators are finally starting to investigate the illegitimate actions of mortgage brokers and the financial institutions that worked with them to produce our current economic situation—commercial banks, insurance companies, investment banks, and credit-rating agencies—S&P stands to be fingered in the process. As so many people have noted, it was the ratings agencies' stamp of AAA on unworthy debt that pushed us into a financial and economic crisis. Could S&P's downgrade be the first signal that they won't take such investigations lying down. They have many weapons that they too can move into battle.

What About the Long-Term?Susan Helper, Professor of Economics, Case Western Reserve University

The S&P is not justified in its downgrade. The U.S. will continue to pay its debts. Investors believe that the U.S. will continue to pay its debts, since they are rushing to buy Treasury bills, driving the rates on those bills down. The stock market is falling not in response to the S&P action, but in response to the combination of bad economic news and the debt-ceiling deal, which makes it very tough for the government to turn this situation around (because it will be hard for the government to issue stimulus to get people back to work). Fearing the worst, traders are selling company stocks that they now think are overvalued, given a continuing depressed economy, and they are investing in the safe harbor of U.S. Treasury bonds. I am not thrilled with Treasury Secretary Timothy Geithner staying on. He has advocated two misguided policies, in my view: (1) bailing out the banks with no strings attached and weakening legislation to forestall another financial crisis and (2) agreeing with the Republican focus on deficits at a time of sky-high unemployment. We could borrow an extra trillion dollars this year, and add only 0.07% of GDP to future debt-service costs.

Using that money to put people back to work makes the long-term deficit problem easier to solve, not harder, because it avoids the problem of people leaving the labor force permanently (and thus not paying taxes).